Economic Policy Of India During Recession

Monetary and Credit Policy

Monetary and Credit Policy is essentially managed by central bank (known by different names in different countries; in India it is the Reserve Bank of India). In a nutshell, this policy is linked with the control of the supply of money and its availability to the people, and the cost of money or rate of interest to bring about economic stability in the system. Monetary policy can be either expansionary or contractionary. The first one increases the total supply of money to face unemployment and recession by lowering the interest rates, and the second one decreases it by raising interest rates to control inflation.

In essence, The Monetary Policy and Credit Policy regulate the supply of money and the cost and availability of credit in the economy. It deals with both the lending and borrowing rates of interest for commercial banks. The Monetary Policy aims to maintain price stability, full employment and economic growth.

The Monetary and Credit Policy is the policy statement, traditionally announced twice a year in India, through which the Reserve Bank of India (RBI) seeks to ensure price stability for the economy essentially by controlling money supply, interest rates and the inflation. This policy also contains norms for the banking and financial sector and the institutions which are governed by it. These would be banks, financial institutions, non-banking financial institutions, money markets foreign exchange market.

Fiscal Policy

The second way to influence the money supply lies in the hands of the government with the Fiscal Policy. The fiscal policy consists of two main tools - The changing of tax rates, and changing government spending. The main point of fiscal policy is to keep the surplus/deficit swings in the economy to a minimum by reducing inflation and recession.

A change in tax rates is usually implemented when inflation is 

Un-usually high, and there is a recession with high unemployment. 

With high inflation, taxes are increased so people have less to spend, thus reducing demand and inflation. During a recession with high 

Un-employment, taxes are lowered to give more people money to spend and thus increasing demand for goods and services, and the economy begins to revive.

A change in government spending has a stronger effect on the 

Economy than change in tax rates. When the government decides to fight a recession it can spend a large amount of money on goods and services, all of which is released into the economy.

Despite the effectiveness of the Fiscal policy, it does have 

drawbacks. It is hard to predict inflation and recession, and it can be a long period of time before the situation is even recognized. As a tax cut can take a year to really take effect, the economy could revive from the recession and the new unnecessary tax cut could cause inflation.

Monetary and fiscal policies are what helps keep the nation’s 

economy stable. With them it is possible to control demand for 

services and goods and the ability to pay for them. It is possible to 

manipulate the money in private hands without directly affecting 

them. The policies are simply a myriad of tools used to prevent a long 

period where there is high unemployment, inflation, and prices, along 

with low wages and investment.

Role Of Monetary And Fiscal Policies During Recession

The RBI has taken many measures since mid-September 2008, to augment domestic liquidity and to ensure that credit continues to flow to productive sectors of the economy. Since then, the RBI has reduced the Cash Reserve Ratio (CRR) from 9.0 per cent to 5.0 per cent and the Statutory Liquidity Ratio (SLR) from 25.0 per cent to 24.0 per cent.

The various fiscal stimulus packages as announced by the government during the last few months or so, have raised the market borrowing programme of the government for the year 2008-09. In terms of the amendment to the memorandum of understanding on ‘Market Stabilisation Scheme’ (MSS) on February 26, 2009, an amount of Rs 45,000 crore was transferred from the MSS cash account to the normal cash account of the Government of India by March 31, 2009. An equivalent amount of government securities issued under the MSS would also form part of the normal market borrowing of the government. This arrangement has surely given a boost to the market.
Furthermore, the RBI has conducted purchase of government securities under its open market operations. The Government has given liquidity support to the housing sector and particularly to Housing Finance Companies (HFC), which have been adversely affected by the recent financial market developments. The government is also helping the overseas financial companies in many ways for financing imports to India. Attempts are being made to ensure adequate liquidity in order to maintain the flow of credit for all productive purposes in the housing, export and small and medium industry sectors.                              


Effects

Despite slowing from highs of 8% to 9% growth, India’s economy will grow close to 6% in 2009. Amid domestic and global liquidity crunch, large domestic savings and corporate retained earnings are financing investment. Sluggish labor market and wealth effects have hit urban consumption. But low export dependence, a large consumption base and the high share of employment (two-thirds) and income (one-half) coming from rural areas has helped sustain consumption. Pre-election spending, especially in rural areas, and high government expenditure, are also pluses. Timely monetary and credit measures have played a key role in improving private demand, liquidity and short-term rates and reducing the risk of loan losses. Credit is largely channeled by domestic banks, especially state-controlled ones, which have low loan-to-deposit ratios and little exposure to toxic assets

On the other hand, the fiscal house is in terrible shape. Just because domestic banks are state controlled does not mean they have low NPAs. Growth rates in the future are also murky. Times were good for the last several years, coasting on good monsoons, tough decisions made by politicians in the past, and a very favorable global climate. Now, global demand has fallen, US/Europe are set to balance away from consumption for some time, and the government has not only produced no major reforms in the last five years, but seems unlikely to produce major reforms in the next five as well.

So relative to the rest of the world, yes India will probably do better. But it also seems unlikely to match the record of the last few years, unless serious steps are taken to curb the deficit, promote infrastructure and human capital, and usher in serious economic reforms.